The investment grade market is experiencing a spike in defaults.
It would be understandable to assume this is Covid-19's fault, but we can’t really blame the pandemic for any of 2020’s casualties so far.
Fraud is the root of the recent insolvency at Wirecard – rated Baa3 just 6 days before default – courtesy of some Filipino bank statements fabricated long before any of us had heard of Covid-19.
Structural challenges and terrible timing have also pushed UK shopping mall operator Intu into administration.
Investment grade defaults are rare (most years there are none) and can be incredibly difficult to identify in advance.
A key feature of any investment grade bond default is that - by definition - its issuer probably looked fine a year ago.
To fall from grace so quickly requires some combination of mismanagement, fraud, an act of God and spectacularly bad luck.
Covid-19 ticks a number of these boxes, and although the pandemic has not yet led to any investment grade defaults, it has already pushed a record $300bn of bonds to junk this year.
We think there is worse to come, and even in a best case, V-shaped economic recovery scenario, we expect fallen angels to nearly double over the course of this crisis.
This could grow to $800bn under a U or W shaped recovery, and to $1.4trn under a very worst case (currently low probability) great depression scenario.
Unsurprisingly we expect this crisis to push up defaults, but – perhaps counter-intuitively – we think that for investment grade companies this rise may take a long time to transpire, and that the peak may be lower than in previous crises.
So despite our terrifying fallen angel predictions, this crisis may not be the disaster for investment grade bond investors that it appears.
Very simply, when companies default it’s usually because they have run out of cash.
For firms that were investment grade when the pandemic hit, this looks unlikely to happen any time soon because central banks around the world have provided all the liquidity that they need.
Even companies without direct access to these schemes have benefited from the resulting bond market frenzy and funding from the high yield market.
For the most vulnerable companies, such as the airlines, liquidity alone is not enough.
Here we see parallels with the global financial crisis, in that some large firms will be considered worthy of bail-outs, albeit for different reasons.
A number of companies may be allowed to fail, but when we try to imagine the 'Lehman' of this crisis, we are looking at a relatively small pool of candidates.
Heading into the global financial crisis almost one third of investment grade corporate bonds were issued by the banking sector, while today’s equivalent - Travel and Leisure - is just 1 per cent of the market.